Term Sheets and Letters of Intent: What Ontario Businesses Must Know Before Signing
Introduction
Before an acquisition closes, before a joint venture agreement is signed, and before a major commercial partnership begins, there is usually a term sheet or letter of intent. These preliminary documents set the stage for the deal by outlining the key commercial terms the parties have agreed on in principle, while leaving the details to be worked out in a definitive agreement.
Term sheets and letters of intent (LOIs) serve a valuable function. They give both parties confidence that there is a meeting of the minds on the fundamental terms of the deal, they provide a roadmap for drafting the definitive agreement, and they allow the parties to commit resources to due diligence and legal work without finalizing every detail. But they also carry legal risks that are not always well understood, particularly regarding which provisions are binding and which are not.
This article explains the role of term sheets and LOIs in Ontario deal-making, identifies the provisions that are typically binding and non-binding, discusses the legal risks of getting this wrong, and offers best practices for Ontario businesses entering into these preliminary agreements.
The Role of Term Sheets and LOIs in Deal-Making
A term sheet or LOI is a document that sets out the principal terms of a proposed transaction. It is used in a wide range of commercial contexts, including mergers and acquisitions, real estate transactions, joint ventures, investment rounds, and major supply or distribution arrangements.
The terms "term sheet" and "letter of intent" are often used interchangeably, though there can be differences in form. A term sheet is typically a summary of deal terms in a table or bullet-point format. A letter of intent is usually drafted in letter form and may contain more narrative description. The legal analysis, however, is the same regardless of the label used: the question is always which provisions are intended to be legally binding and which are not.
The primary purpose of these documents is to confirm that the parties have reached a preliminary understanding on the core terms of the deal before investing significant time, money, and legal resources in negotiating and drafting a comprehensive definitive agreement. They also serve as a communication tool, ensuring that all parties (and their lawyers) are working from the same set of assumptions.
Binding vs. Non-Binding Provisions
The most important feature of a well-drafted term sheet or LOI is a clear statement of which provisions are binding and which are not. This distinction is critical because the consequences of inadvertently creating a binding obligation can be severe.
Typically Binding Provisions
Even when a term sheet or LOI states that it is "non-binding" overall, certain provisions are almost always intended to be binding from the moment the document is signed:
• Confidentiality. The parties will be exchanging sensitive information during due diligence and negotiations. The obligation to keep that information confidential must be binding from the outset.
• Exclusivity (no-shop). The buyer or investor often requires the seller or target not to solicit or entertain competing offers for a specified period. This exclusivity provision must be binding to be meaningful.
• Costs and expenses. The allocation of transaction costs (such as who pays for legal, accounting, and due diligence expenses, and whether those costs are shared in the event the deal does not close) is typically binding.
• Governing law and dispute resolution. The provisions determining which law governs the term sheet and how disputes will be resolved are binding.
• The non-binding clause itself. The provision stating which parts of the term sheet are not binding must be binding, or the entire framework collapses.
Typically Non-Binding Provisions
The commercial deal terms, such as the purchase price, the structure of the transaction, the representations and warranties, the closing conditions, and the indemnification provisions, are typically expressed as non-binding. The parties intend these terms to be subject to the negotiation and execution of a definitive agreement. If the definitive agreement is never signed, these terms do not create binding obligations.
The non-binding nature of the deal terms must be stated clearly and unambiguously. Language such as "This term sheet is intended as a summary of the principal terms of the proposed transaction and does not constitute a binding agreement, except as expressly stated herein" is standard.
Legal Risks of Term Sheets and LOIs
Inadvertent Binding Effect
The most significant risk is that a court may find the term sheet or LOI to be a binding contract, even if the parties did not intend it to be. This can happen where the document is insufficiently clear about which provisions are binding and which are not, where the language of the document suggests a present commitment rather than an agreement in principle, or where the parties begin performing as though the deal has closed before a definitive agreement is signed.
Ontario courts look at the objective intention of the parties as expressed in the document and the surrounding circumstances. If the term sheet reads like a contract, contains all the essential terms of a deal, and does not clearly state that it is non-binding, a court may conclude that the parties intended to create immediate legal obligations.
Duty to Negotiate in Good Faith
Following the Supreme Court of Canada’s decision in Bhasin v Hrynew, 2014 SCC 71, there is a recognized duty of honest performance in the exercise of contractual obligations. While Canadian courts have been cautious about imposing a free-standing duty to negotiate in good faith, the binding provisions of a term sheet or LOI (such as an exclusivity clause) carry with them an implied duty of honest performance.
This means that a party cannot enter into an LOI with an exclusivity provision and then use the exclusivity period to continue negotiating with competitors in secret, or string along the other party while having no genuine intention of completing the deal. Such conduct could give rise to a claim for damages.
The scope of the duty to negotiate in good faith in the pre-contractual context remains an evolving area of Canadian law. Parties should proceed on the assumption that they must act honestly throughout the negotiation process, even where the deal terms are expressly non-binding.
Break Fees
A break fee (also known as a termination fee or reverse break fee) is a provision requiring one party to pay a specified amount to the other if the deal does not close under certain circumstances. Break fees are common in M&A transactions and serve several purposes: they compensate the non-breaching party for its out-of-pocket costs, they deter a party from walking away from the deal without good reason, and they provide certainty about the financial consequences of a failed transaction.
If a term sheet includes a break fee, the provision must be clearly identified as binding. A break fee that is buried in the non-binding deal terms may be unenforceable.
Key Components of a Well-Drafted Term Sheet or LOI
A well-structured term sheet or LOI typically includes the following elements:
1. Identification of the parties. The full legal names of all parties to the proposed transaction.
2. Transaction overview. A summary of the proposed transaction, including its structure (asset purchase, share purchase, investment, partnership, etc.) and the key commercial terms (price, payment terms, and any earn-out or holdback provisions).
3. Conditions precedent. The conditions that must be satisfied before the definitive agreement will be signed or the transaction will close, such as satisfactory due diligence, board approval, regulatory approval, or financing.
4. Timeline. A proposed timeline for completing due diligence, negotiating the definitive agreement, and closing the transaction.
5. Confidentiality. The obligations of each party to keep the negotiations and the information exchanged confidential.
6. Exclusivity period. If applicable, a commitment by one or both parties not to solicit or entertain competing offers for a specified period.
7. Costs and expenses. The allocation of transaction costs, including who pays in the event the deal does not close.
8. Termination. The circumstances under which the term sheet or LOI itself can be terminated, such as the expiration of the exclusivity period or the failure to agree on a definitive agreement by a specified date.
9. Binding and non-binding provisions. A clear statement identifying which provisions are binding and which are non-binding.
10. Governing law and jurisdiction. The law governing the term sheet and the forum for resolving disputes.
Best Practices for Ontario Businesses
• Always clearly label which provisions are binding and which are not. A single, unambiguous clause at the beginning or end of the document is the most effective approach.
• Avoid language that suggests a present, unconditional commitment. Use phrases like "the parties intend to negotiate" or "subject to the execution of a definitive agreement" rather than "the buyer agrees to purchase" or "the seller will transfer."
• Keep the non-binding deal terms at a high level. The more detailed the term sheet, the greater the risk that a court will find it constitutes a binding agreement. Save the details for the definitive agreement.
• Set realistic timelines. Overly ambitious deadlines create pressure that can lead to mistakes in the definitive agreement or to disputes about whether a party has negotiated in good faith.
• Do not begin performing the transaction before the definitive agreement is signed. Conduct that is consistent with a binding contract (such as transferring assets, making payments, or integrating operations) can undermine the argument that the term sheet was non-binding.
• Obtain legal advice before signing. A lawyer can ensure that the term sheet protects your interests, correctly identifies the binding and non-binding provisions, and does not inadvertently create obligations you did not intend.
Frequently Asked Questions
Q: Is a term sheet the same as a letter of intent?
A: Functionally, yes. Both documents serve the same purpose: to outline the principal terms of a proposed deal before a definitive agreement is negotiated. The term "term sheet" tends to be used for shorter, more structured summaries, while "letter of intent" typically takes a more narrative form. The legal analysis is the same regardless of the label.
Q: Can I walk away from a deal after signing a term sheet?
A: If the deal terms are clearly stated as non-binding and subject to the execution of a definitive agreement, you can generally decline to proceed with the transaction. However, you must comply with any binding provisions (such as confidentiality and exclusivity) and you must act honestly in your negotiations. Walking away in bad faith or in violation of a binding exclusivity clause can expose you to a damages claim.
Q: What happens if the term sheet does not say whether it is binding or non-binding?
A: This is the worst-case scenario. If the document is ambiguous, a court will look at the language used, the surrounding circumstances, the conduct of the parties, and the completeness of the terms to determine whether the parties intended to create binding legal obligations. The risk of an unfavourable finding is significant, which is why every term sheet and LOI must include a clear binding/non-binding clause.
Q: How long should an exclusivity period last?
A: Exclusivity periods typically range from 30 to 90 days, depending on the complexity of the transaction and the amount of due diligence required. The period should be long enough to allow the parties to negotiate the definitive agreement in good faith, but not so long that it unreasonably prevents the seller or target from pursuing other opportunities if the deal falls through.
Q: Do I need a lawyer to draft a term sheet?
A: You should strongly consider it. While the commercial terms of a deal are typically driven by the business principals, a lawyer is essential for ensuring that the binding and non-binding provisions are correctly identified, that the language does not inadvertently create binding obligations, and that the document adequately protects your interests. The cost of legal review at the term sheet stage is modest compared to the cost of litigating a dispute about whether the term sheet was binding.
Contact Booni Law
Whether you are entering negotiations for a business acquisition, investment, joint venture, or major commercial partnership, Booni Law can help you draft and negotiate term sheets and letters of intent that protect your interests and set the right foundation for the deal. Booni Law serves clients across Ontario, including the Greater Toronto Area, Southwestern Ontario, and communities throughout the province. Email us at admin@boonilaw.com or call +1 (226) 271-1751 to get started.
Disclaimer: This article is provided for general informational purposes only and does not constitute legal advice. Reading this article does not create a solicitor-client relationship between you and Booni Law. The information in this article may not reflect the most current legal developments and should not be relied upon as a substitute for professional legal advice tailored to your specific circumstances. If you require legal advice, please contact Booni Law.
